Transcript The International Gold Standard, 1879-1913

International Monetary Arrangements
in Theory and Practice
 The
international monetary system is
the institutional framework within
which:



International payments are made.
Movements of capital are accommodated.
Exchange rates among currencies are
determined.
The International Gold Standard,
1879-1913
Fix an official gold price or “mint parity” and allow
free convertibility between domestic money and
gold at that price.

Countries unilaterally elected to follow
the rules of the gold standard system,
which lasted until the outbreak of World
War I in 1914, when European
governments ceased to allow their
currencies to be convertible either into
gold or other currencies.
The International Gold
Standard, 1879-1913
For example, if the dollar is pegged to gold
at U.S.$30 = 1 ounce of gold, and the British
pound is pegged to gold at £6 = 1 ounce of
gold, it must be the case that the exchange
rate is determined by the relative gold
contents:
$30 = £6
$5 = £1
The International Gold
Standard, 1879-1913


Highly stable exchange rates under the
classical gold standard provided an
environment that was conducive to
international trade and investment.
Misalignment of exchange rates and
international imbalances of payment were
automatically corrected by the price-specieflow mechanism.
Price-Specie-Flow Mechanism


Suppose Great Britain exported more to France than
France imported from Great Britain.
This cannot persist under a gold standard.
–
–

Net export of goods from Great Britain to France will be
accompanied by a net flow of gold from France to Great
Britain.
This flow of gold will lead to a lower price level in France and,
at the same time, a higher price level in Britain.
The resultant change in relative price levels will slow
exports from Great Britain and encourage exports
from France.
The International Gold
Standard, 1879-1913



With stable exchange rates and a common
monetary policy, prices of tradable commodities
were much equalized across countries.
Real rates of interest also tended toward equality
across a broad range of countries.
On the other hand, the workings of the internal
economy were subservient to balance in the
external economy.
The International Gold
Standard, 1879-1913

There are shortcomings:
–
–
The supply of newly minted gold is so restricted
that the growth of world trade and investment can
be hampered for the lack of sufficient monetary
reserves.
Even if the world returned to a gold standard, any
national government could abandon the standard.
The Relationship between Money and
Growth






Money is needed to facilitate economic transactions.
MV=PY →The equation of exchange.
Assuming velocity (V) is relatively stable, the
quantity of money (M) determines the level of
spending (PY) in the economy.
If sufficient money is not available, say because gold
supplies are fixed, it may restrain the level of
economic transactions.
If income (Y) grows but money (M) is constant, either
velocity (V) must increase or prices (P) must fall. If
the latter occurs it creates a deflationary trap.
Deflationary episodes were common in the U.S.
during the Gold Standard.
Interwar Period: 1918-1941





Exchange rates fluctuated as countries widely used
“predatory” depreciations of their currencies as a
means of gaining advantage in the world export
market.
Attempts were made to restore the gold standard,
but participants lacked the political will to “follow the
rules of the game”.
The result for international trade and investment was
profoundly detrimental.
Smoot-Hawley tariffs
Great Depression
Economic Performance and Degree of
Exchange Rate Depreciation During the
Great Depression
The Spirit of the Bretton Woods
Agreement, 1945
Fix an official par value for domestic currency in
terms of gold or a currency tied to gold as a numeraire.
In the short run, keep the exchange rate pegged within
1% of its par value, but in the long-run leave open the
option to adjust the par value unilaterally if the IMF
concurs.

In essence, the Agreement removed
countries from the tyranny of the gold
standard and permitted greater autonomy for
national monetary policies
Bretton Woods System:
1945-1972




Named for a 1944 meeting of 44 nations at
Bretton Woods, New Hampshire.
The purpose was to design a postwar
international monetary system.
The goal was exchange rate stability without
the gold standard.
The result was the creation of the IMF and
the World Bank.
Bretton Woods System:
1945-1972





Under the Bretton Woods system, the U.S. dollar
was pegged to gold at $35 per ounce and other
currencies were pegged to the U.S. dollar.
Each country was responsible for maintaining its
exchange rate within ±1% of the adopted par value
by buying or selling foreign reserves as necessary.
The U.S. was only responsible for maintaining the
gold parity.
This created strong demand for $ reserves and
allowed the U.S. to run trade deficits.
The Bretton Woods system was a dollar-based gold
exchange standard.
The Fixed-Rate Dollar Standard, 1945-1972
In practice, the Bretton Woods system
evolved into a fixed-rate dollar standard.
Industrial countries other than the United States :
Fix an official par value for domestic currency in terms
of the US$, and keep the exchange rate within 1% of
this par value indefinitely.

United States : Remain passive in the foreign exchange
market; practice free trade without a balance of
payments or exchange rate target.
Bretton Woods System: 1945-1972
British
pound
German
mark
Par
Value
U.S. dollar
Gold
Pegged at
$35/oz.
French
franc
Purpose of the IMF



The IMF was created to facilitate the orderly
adjustment of Balance of Payments among
member countries by:
encouraging stability of exchange rates,
avoidance of competitive devaluations, and
providing short-term liquidity through loan
facilities to member countries
Composition of SDR
(Special Drawing Right)
Collapse of Bretton Woods






Triffin paradox – world demand for $ requires U.S. to run
persistent balance-of-payments deficits that ultimately leads to
loss of confidence in the $.
SDR was created to relieve the $ shortage.
Throughout the 1960s countries with large $ reserves began
buying gold from the U.S. in increasing quantities threatening
the gold reserves of the U.S.
Large U.S. budget deficits and high money growth created
exchange rate imbalances that could not be sustained, i.e. the $
was overvalued and the DM and £ were undervalued.
Several attempts were made at re-alignment but eventually the
run on U.S. gold supplies prompted the suspension of
convertibility in September 1971.
Smithsonian Agreement – December 1971
The Floating-Rate Dollar Standard, 1973-1984

Without an agreement on who would set the
common monetary policy and how it would be set,
a floating exchange rate system provided the only
alternative to the Bretton Woods system.
The Floating-Rate Dollar Standard, 1973-1984
Industrial countries other than the United States :
Smooth short-term variability in the dollar exchange
rate, but do not commit to an official par value or to
long-term exchange rate stability.
United States : Remain passive in the foreign exchange
market; practice free trade without a balance of
payments or exchange rate target. No need for sizable
official foreign exchange reserves.
The Floating-Rate Dollar Standard, 1973-1984

Essentially, the foreign exchange rate was
left to play the role of a residual variable that
did a great deal of the adjusting to offset the
macroeconomic policy differences across
countries.
The Plaza-Louvre Intervention Accords and
the Floating-Rate Dollar Standard, 1985-1999
Germany, Japan, and the United States (G-3) :
Set broad target zones for the $/DM and $/¥ exchange
rates. Do not announce the agreed-upon central rates,
and allow for flexible zonal boundaries. Allow the
implicit central rates to adjust when economic
fundamentals among the G-3 countries change
substantially.
Other industrial countries : Support or do not oppose
interventions by the G-3 to keep the dollar within its
target zone limits.
The Plaza-Louvre Intervention Accords and
the Floating-Rate Dollar Standard, 1985-1999
An episode started by an expansive U.S. fiscal policy
introduced in 1981 combined with tight monetary control
convinced policymakers that …
 exchange rates were too important to be left to market
forces

–

intervention was deemed appropriate
exchange rates were too important to be the residual from
uncoordinated economic policies
–
better policy coordination was required.
Value of $ since 1965
Current Exchange Rate
Arrangements

Free Float
–

Managed Float
–

About 25 countries combine government intervention with
market forces to set exchange rates.
Pegged to another currency
–

The largest number of countries, about 48, allow market
forces to determine their currency’s value.
Such as the U.S. dollar or euro (through franc or mark).
No national currency
–
Some countries do not bother printing their own, they just
use the U.S. dollar. For example, Ecuador, Panama, and El
Salvador have dollarized.